Why June’s rise in leading economic indicators helps homebuilders

The Conference Board Leading Economic Index is a forward-looking index mainly used to identify turning points in the economy

The index of Leading Economic Indicators (the LEI) is a business cycle indicator. It’s based on 11 different economic statistics: average workweek, initial jobless claims, new orders, building permits, unfilled durable goods, commodity prices, consumer expectations, stock prices, and money supply.

Since it’s a combination of previously released indices, it isn’t really a market-moving release. This index can be volatile, so analysts tend to identify three-month trends as an indication that the economy is moving into another part of the business cycle.

Why June’s rise in leading economic indicators helps homebuilders

The Index of Leading Economic Indicators increases in June

After a strong March, the Index of Leading Economic Indicators slipped in April but rebounded to +0.7 in May. The index fell back to 0.3 in June, though. Overall, the index shows an economy that’s accelerating. Asset prices and interest rates were positive, offset by weakness in consumer expectations about the economy.

“The CEI shows the pace of economic activity continued to expand moderately through June,” said Ken Goldstein, economist at The Conference Board. “Stronger consumer demand driven by sustained job gains and improving confidence remains the main source of improvement for the U.S. economy. In addition to a stronger housing market, more business investment could also provide an upside to the overall economy.”

Ever since President Obama mentioned a “recovery summer” early in his tenure, the term has become a bit of a running joke. The economy remained tepid. This summer, however, we may actually see a recovery.

Implications for homebuilders

Overall, the report shows that the economy is still expanding moderately and that the labor market should start improving. Sentiment is generally improving. But the overall economy is growing slowly, which is worrisome for increasing employment.

Jobs are the most important economic statistic for homebuilders. They need to see an increase in job growth to get some activity from the first-time homebuyer.

Overall increases in consumer sentiment, however modest, are starting to drive more business for homebuilders like Lennar (LEN), D.R. Horton (DHI), Toll Brothers (TOL), and PulteGroup (PHM). Housing starts have been so low for so long that there’s some real pent-up demand that will unleash as the economy improves. The shortage of skilled workers can negatively affect margins as business expands.

Homebuilder earnings have been generally good, which supports the reading from the Conference Board. An alternate way to invest in the homebuilding sector would be through the S&P SPDR Homebuilder ETF (XHB).